LIMITATIONS OF INTERNAL

CONTROL
Christine Therese C.
Brazula
BSA 3-3

LIMITATIONS OF INTERNAL CONTROL

Inherent limitations to the

effectiveness of internal control
system
Management Override of Internal Control
Personnel Errors or Mistakes
Collusion

LIMITATIONS OF INTERNAL CONTROL

Management Override of Internal

Control

Back dating or forward dating documents to a different

period.
Making adjusting entries during the financial reporting closing
process.

LIMITATIONS OF INTERNAL CONTROL

Personnel Errors or Mistakes

Mistake in judgment
Do not completely understand the instructions
Careless

LIMITATIONS OF INTERNAL CONTROL

Collusion

The effectiveness of segregation of duties lies in the

individuals performing only their assigned jobs or in the
performance of one person being checked by another. These
controls can be circumvented by collusion.

REASONABLE ASSURANCE

CONSIDERATION OF INTERNAL
CONTROL IN A FINANCIAL
STATEMENTS AUDIT

CONSIDERATION OF INTERNAL CONTROL IN A FINANCIAL STATEMENTS

AUDIT

Objective
Management has the responsibility to maintain controls that
provide reasonable assurance that adeqaute control systems
exists over the entity's assets and records. Management has
a control system that generates reliable information for
decision making. The auditor should give adequate
considerations to these controls because the quality of the

CONSIDERATION OF INTERNAL CONTROL IN A FINANCIAL STATEMENTS

AUDIT

Stages of Study and Evaluation of

Internal Control

1.Obtain an understanding of internal control.

2.Assessing the preliminary level of control risk.
3.Obtaining the evidential matter to support the assessed
level of control risk.
4.Evaluating the results of evidential matter.

STAGES OF STUDY AND EVALUATION OF INTERNAL CONTROL

Obtaining an understanding of
internal control

The knowledge obtained is used to:

Identify types of potential misstatements.
Consider factors that affect the risk of material miss
Design substantive tests.

STAGES OF STUDY AND EVALUATION OF INTERNAL CONTROL

Obtaining an understanding of
internal control
An initial understanding of the design of the entity's internal
control is normally obtained by:
Inquiry of appropriate entity personnel.
Inspection of documents and reports.
Observation of the application of controls

OBTAINING AN UNDERSTANDING OF INTERNAL CONTROL

Five components of internal control

Understanding the control environment
Understanding the entity's risk assessment process
Understanding control activities
Understanding the information system and communication
(by performing a walk-through test)
Understanding monitoring of controls

OBTAINING AN UNDERSTANDING OF INTERNAL CONTROL

The documentation usually takes the

form of:

Internal control questionnaire

Narrative description
Flowcharts

OBTAINING AN UNDERSTANDING OF INTERNAL CONTROL

Method
Questionnai
re

Narrative
Description
or
Memorandu
m

Flowchart

Description

Advantages

Disadvantages

provide a systematic means for

the auditor to investigate areas
such as internal control structure.

Easy to complete
Important portions of the
Internal Control are unlikely to
be overlooked
Weakness become obvious

May be answered without

adequate consideration
Standardized
questionnaires may not fit
client adequately

describes the flow of transaction

cycles, identifying the employees
performing various tasks,
documents prepared, records
maintained , and division of
duties

Tailor-made to fit specifi

engagement
Requires a detailed analysis of
the operations and thus,
enable the auditor to
understand the function

May become very long and

time-consuming
Weaknesses in the
structure are not always
obvious
Important portions of the
Internal Control may be
overlooked

a symbolic representation of an
entity's internal control system or
a series of procedures shown in
sequence

graphic presentations of the

structure
Important portions of the
Internal Control will not
overlooked
Good for electronic systems

Preparation is timeconsuming
Weakness in the structure
is not obvious

Stages of Study and Evaluation of Internal Control

Assessing the Preliminary Level of

Control Risk
The level of control risk is established either at the maximum
level or below the maximum level.
The term maximum level means the greatest probability
that a material misstatement that could occur in a financial
statement assertion will not be prevented or detected on a

ASSESSING THE PRELIMINARY LEVEL OF CONTROL RISK

Three instances when test of control

will not be performed
Controls are believed to be ineffective and control risk is
assessed at maximum
Controls are believed to be effective, but testing them is not
cost efficient and therefore control risk is assessed at
maximum level
Controls are believed to be effective and evidence already
obtained is adequate to support planned level of control risk

ASSESSING THE PRELIMINARY LEVEL OF CONTROL RISK

Assessing the control risk below

maximum level
Identify relevant controls that will be relied upon
Perform test of control
Conclude on the achieved level of control risk